~ Thinking about how many times I have fallen. Spirits are using me larger voices calling. CS&N

Do the Bitcoin Markets Like Mtgox Set a Value for Bitcoin?

Dave is determined to get to the bottom of things. Undaunted by the twists and turns of his Don Quixote like campaign to educate the masses about bitcoin, Dave meets each new dragon in turn, smiting it with his lightning lance of logic.

Today we are going to discuss a question people have about bitcoin. Let’s set it up as a logical syllogysm.

2. But bitcoin certainly does have a clearly established price. Just go over to mtgox.com, or some other bitcoin trading site, and it is posted up there for all to see, in every major currency. For example, last week it was $266 per bitcoin. Right now it is $65 per bitcoin.

3. Since 2 contradicts 1, and 2 is a fact, whereas 1 is a theory, 2 wins.

4. Thus 1 is wrong, and either the regression theorem is wrong, or Dave misunderstood it.

That’s the argument one sees over and over on the internet.

Devil’s Advocate: They sure got a slam dunk on you this time, Dave. You have been facialed.

Smiling Dave: Not exactly, Devil. I’ve dealt with this question in scattered places in my articles, and now I’ll tie them all together.

DA: I know you are going to say the price on mtgox.com doesn’t count, right? What lame reason have you for that?

SD: Let me give you a homely little story. At one time, a naive innocent was approached by a drug dealer. A powerful new strain of marijuana is now available, he told the innocent. And we only have it here in California. I’ll sell you a pound for $1,500, and you can take it to New York and contact my pal, Wheelo, a big dealer there. He will buy it off you for much more, because everyone will love that stuff in New York.

The innocent met Wheelo, who laughed at his asking price. But I paid $1,500 a pound for it, Wheelo. I’m not asking anything unreasonable.

That’s the price when you buy from a drug dealer, innocent, not the price when you sell to one.

DA: And your point is?

SD: The same applies to bitcoin. Those mtgox.com prices are phony. Sure, if you want to buy bitcoins, that’s what it will cost you, that price listed on mtgox. But if you try to sell them, you will get much much less, like half or less of the listed price.

DA: What are you talking about, Dave? People sell bitcoins there all the time.

SD: No they don’t. Let me quote from the respected financial website, fool.com:

…only about 3% of all Bitcoins are in circulation at the moment, and less than 1% of all Bitcoins currently in existence are sold on the exchanges…less than 10% of wallet users [are] actually engaged in transacting their Bitcoins…

…if I sell a million Bitcoins, the price will crash through the floor, because there simply aren’t that many people actually looking to buy any Bitcoins.

Very few people want to sell their Bitcoins, even though the user base is already fairly tiny.

DA: OK, so he is saying people don’t usually try to sell. He claims that if they do, the price will drop like a stone. Has he any evidence?

SD: He sure does. Look at what happened this last week. Bitcoin dropped like a stone all right, from $266 to $66. Not the first time it’s happened, either.

DA: But Dave, all things drop in price when there are many of them offered for sale.

SD: The fellow quoted explains the difference:

If I had a million shares of Bank of America, I could sell them and…my sale would barely move the price of a stock that experiences at least 200 times that much trading volume on any given day.

DA: Alas and alack, Dave, we are all suckers. The Regression Theorem is true. Smiling Dave was right!

Sure, there is a limit to the amount of bitcoins you can sell quickly without significantly moving the market price. That doesn’t mean it’s useless, it just limits how big amounts it’s useful for. The more traders on the market, the bigger the amounts will be that are practical.

There is no need to hold bitcoins to make use of them for global and fast transfers of value. Speculators will do the holding for you. For example, there already is a wallet service (Bridgewalkerapp) that sends and receives bitcoins while storing your balance as dollars. For merchants there’s BitPay who’ll take the currency risk for a fee of 0.99% and will wire the merchant their payments in dollars in one business day.

For the use cases I outlined here, bitcoin’s market price is completely irrelevant as long as it’s above zero.

The difference is that all other software is not trying to be money. Bitcoin is.

Why does that matter? Very simple. With M$, Oracle Cisco etc. a potential buyer knows how much it is worth to him to own them. If I use these programs in my business, it will save me X dollars. If they are games, they will provide me with X dollars of pleasure. So their price can be determined.

But with bitcoin, it is different. A potential recipient says to himself, “This is supposed to be money, meaning I can buy stuff with it. How much stuff? Ten dollars worth? A hundred dollars worth? It depends on how much the shop will give in exchange for my bitcoin. How will they decide? Actually, they are in the same fix I am in. They don’t know either.”

argument #2: Can we escape regression theorem, if we cross some mass Bitcoin adaptation threshold?

Lets say somehow 90% of world accepts to run on bitcoin (after some apocalyptic dollar+euro+yen+other major currencies collapse in 2045). Only 10% bother about Regression theorem. Prices are somewhat arbitrary but somehow economy is functioning, world accepts to fix gold price by following BitCoinToGold formula: 21 million/total gold supply = Bitcoin value per unit gold. I think once gold is calibrated against Bitcoin it should be easy to calculate prices in gold of all other goods (as gold is already a good currency).

Now 10% even if they dump all their Bitcoins, 90% have accepted the BitCoinToGold Formula… a little game theory should tell 90% ppl will not allow 10% dumping to escalate further (like other non US countries holding massive USD will lose too if they dump USD, this keeps USD from totally being dumped).

Now we have averted bubble in gold, calibrated Bitcoin against gold with simple formula, derived all other prices via gold (lets call this price booting via gold), protected Bitcoin using game theory.

Have I salvaged Bitcoin from regression theorem?

PS: I am just an average dude with lot of free time, so sometimes I write total fantasy with no link to reality !

BTW, since you are familiar with game theory, I have a question. I’ve heard that nobody actually goes out there and solves a real world problem using game theory. What I mean is, an engineer will use his complex variable theory, a physicist will use calculus all the time, a pollster will use statistics, but nobody consults their game theory book when they have to solve any real life problem whatever. Is this true or false, to your knowledge?

Game theory, is everywhere, may be it doesn’t have a public iconic branding.
Everybody is a player and they have unique personal payoff matrix(unlike rational agent assumption of some economists, matrix values are subjective), it explains suicide bombers, politicians, divorces, mergers & takeovers, price discovery, instability of cartels, stability of religions etc etc. (I haven’t read human action by Mises but I think it should be another way of packaging game theory insights).

The paper is right here: http://arxiv-web3.library.cornell.edu/pdf/1410.1231v1.pdf The quotes are from here: http://newsoffice.mit.edu/2014/mit-computer-scientists-can-predict-price-bitcoin Devil’s Advocate: So MIT Guy. I bet you …Continue reading →